CORPORATE FINANCE

Corporate Finance



Corporate Finance

Answer 1)

(a) You have included the following securities in your portfolio:

Security

Investment

Expected Return

Beta

A

$4 000

6.20%

0.95

B

$7 500

4.80%

1.48

C

$8 200

7.10%

1.11

D

$5 300

5.90%

0.68

Expected return of the portfolio

1

2

3

4

2*4

Security

Investment

Expected Return

Beta

Wright of the portfolio

Expected impact on portfolio

A

$4,000

6.20%

0.95

16.00%

0.99%

B

$7,500

4.80%

1.48

30.00%

1.44%

C

$8,200

7.10%

1.11

32.80%

2.33%

D

$5,300

5.90%

0.68

21.20%

1.25%

Total

$25,000

 

 

1

6%

The formula for expected rate of return of the portfolio is

After applying this formula, the expected rate of return of the portfolio is 6% which means that the portfolio will return at least 6% from the entire portfolio.

Beta of the portfolio

1

2

3

4

3*4

Security

Investment

Expected Return

Beta

Wright of the portfolio

Beta impact on portfolio

A

$4,000

6.20%

0.95

16.00%

0.15

B

$7,500

4.80%

1.48

30.00%

0.44

C

$8,200

7.10%

1.11

32.80%

0.36

D

$5,300

5.90%

0.68

21.20%

0.14

Total

$25,000

 

 

1

1.10424

The beta of the portfolio is 1.104 which is slightly higher than the market and it is almost 1 the shares are in line with the market. The perception of the investors regarding the market is that it will rise in the future. Therefore, on the whole the risk of the portfolio will be better managed is the greater perspective of share diversification.

b) Security A has an expected rate of return of 22 percent and a beta of 2.5. Security B has a beta of 1.20. If the Treasury note rate is 10 percent, what is the expected rate of return for Security B?

Security

Expected Rate of Return

Beta

A

22%

2.5

-B

?

1.2

Treasury note rate

10%

 

From the information, expected rate of return for security B can be obtain through CAPM model. The following is the formula of CAPM mode:

R = Rf + (Rm + Rf) x ß

Where Rf is the rate on treasury note

Rm is the market return

ß is the Beta

In order to get market return, this can be obtained from the information available for the Security A.

0.22 = 0.1 + (Rm - 0.1) x 2.5

= 14.8%

R = Rf + (Rm - Rf) x ß

= 10 %+( 14.8% - 10%) * 1.2

= 15.7600%

The expected rate of return for the security B is 15.7600%

c) What are the two components of a security's risk? What can an investor do about them (answer is limited within 200 words)?

The two components of security risks are Systematic and unsystematic risk. Systematic risks are those risks which cannot be controlled by the organization and they are termed as macro nature, as far as Unsystematic risks are concern they are controllable and they usually occur within the company and hence termed as micro nature. These risks are further classified in different risks.

When a person decides to invest in stocks, they needed to take risks. It is necessary for investors to know about these risks as systematic risks are uncontrollable. Such as, a global turn-oil would impact on the entire stock market which means that investors stock will also be affected in the same way change in interest rate also badly impact on the entire market and there are some sectors which have directly association with other sectors and hence they also suffer. Therefore, investors should consider this as they cannot be diversified and should be aware of such type of risks (Finch, ...